German Bund approaches important resistance

Rates

Sentiment on global core bond markets remains positive. Risk appetite turned into risk aversion during European dealings and triggered a safe haven bid for bonds. Especially the Bund profited, because the decline in European stocks was more outspoken than in US equities. After the (weak) closure of European equities, US equities rebounded. The Bund held on to its gains, but US Treasuries returned the (smaller intraday gains). The 10-yr yield spread US-Germany widened by 5 bps, the 2-yr spread by 3.2 bps. The Bund approached the upper bound of the recent trading range (156.84). The underperformance of US Treasuries may be due to the price pattern in the equity markets, but also to the upcoming payrolls report. Fed Williams was very hawkish (see below), but his impact was not visible in the intraday price action, even as the 2-yr underperforms the 10-yr overnight. At the time of writing, the German yield curve shifts 1.6 bps (2-yr) to 5.1 bps lower (10-yr), the curve bull flattening. Changes on the US yield curve are limited between +1.6 bps (2-yr) and 0 bps (10-yr). On intra-EMU bond markets, 10-yr yield spreads vs Germany narrow up to 3 bps (Ireland) with Greece outperforming (-9 bps).

Can payrolls keep rate hike expectations alive?

Today the US Sept Nonfarm payrolls will be released. In August, US non-farm payrolls increased by 173 000, which was a big drop after solid payrolls for the previous three months. However, statistically the first release of the August payrolls is usually revised sharply upward. So, we expect August payrolls to be revised to above 200 000. For September, the consensus looking for a payrolls increase by 200 000. The ADP report already showed a decent pick-up in private sector hiring and the initial claims remained at a cyclical low level. The ISM employment sub-index was weaker at 50.1 though from 51.7 in August, but the consensus expects already a flat manufacturing employment figure. However, the service sector employment should be strong. Statistically, also September has a negative bias for the first reading and the survey week is falling very early. (12th was a Saturday) which might be slightly negative for the AHE and the length of the workweek. Overall, the risks are for a slightly lower September outcome, however that would be compensated by upward revisions to the lower August payrolls. The unemployment rate is expected to stabilize at the 5.1% that was reached in August, which is also within the Fed’s target range of maximum sustainable employment (4.9% to 5.2%), but a downward surprise should have its impact.

Average hourly earnings are forecast to have increased by 0.2% M/M for September, increasing the annual rate to 2.4% Y/Y, but may fall short for statistical-technical reasons.

SF Fed Williams close to tipping point

SF Fed governor Williams sounded somewhat hawkish yesterday though most of his remarks echoed comments on Monday. The decision to hold off on raising rates was a close call in September and it doesn’t take a lot of information to tip the balance. Today’s payrolls might be that key piece of info. Williams said that he is “just looking for steady, continuing improvement in the labor market, continuing improvement in the economy. Above 100 000 or 150 000 would be good to me.” A slower pace of payrolls growth at this stage suggests that the labour market is closer to being healed. Williams’ comments suggest that the bar isn’t that high to flip in favour of a hike. As a voting member and close ally to Fed chairwoman Yellen, that’s an important signal. He also confirmed that October is a “live” meeting.
Finally, he sharpened his language around the risk of financial imbalances again by calling for attention to rising asset price. “You don’t let an economy rip, that usually ends badly”, he added.

Today: Payrolls Friday!

Overnight, Asian stocks markets trade marginally lower. Apart from SF Williams’ comments, news flow is thin. The US Note future trades flat, but the front end of the US curve slightly underperforms. ECB Draghi said that the EMU has become more resilient and that growth is picking up.

Today’s eco calendar focusses on the US payrolls report. Ahead of the release, trading will likely be thin and sideways. We see risks for the payrolls slightly on the downside of expectations. That could trigger a test of the contract high in the US Note future (129-10+), but we don’t expect a break. In case of an upward surprise, the reaction (lower) could be larger given this week’s positioning (for a weaker outcome) and yesterday’s Fed Williams comments. Risk on equity markets is still fragile and remains a wildcard for trading. After European closure, Fed’s Harker, Fischer and Bullard speak. Given their profiles, they might add weight to Williams’ recent hawkish comments which could further weigh on the front end of the US curve (especially if vice chair Fischer is hawkish).

Technically, we eye rangebound trading for the Bund and US Note future. (Bund: 152.75 – 156.84; US Note future 126-16+ - 129-10+). A test of the topside could occur on weaker payrolls, we don’t anticipate sustained breaks higher.

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